THE BREAKFAST BRIEFING

One of Wall Street’s bullish strategists struck a surprisingly cautious tone on Monday, saying he expects a big drop in the stock market over the coming weeks.

Less than a week after the Dow Jones Industrial Average surpassed 17000 for the first time, Jeffrey Saut, chief market strategist at Raymond James, said the rally is due for a breather. He still believes in the long-term fundamentals of the rally, saying the secular bull market has several years left to run. But first, stocks are due for a drop before notching another leg higher, he said.

“I am making a ‘call’ for the potential of the first decent pullback of the year to begin in mid-July or early August,” Mr. Saut told clients on Monday. He recommended investors raise cash positions and trim their exposure to U.S. stocks in anticipation of the pullback.

The market’s “internal energy readings” are comparable to what took place in the summer of 2011, he said, when Europe’s debt crisis and a downgrade of the U.S. credit rating ushered in an 18% decline for the S&P 500. The fundamentals are far different now, of course, but Mr. Saut said the trading environment appears set up for a market decline.

“While I do not think any pullback from here will be that severe, I do think we are vulnerable to a 10% – 12% decline in the weeks ahead,” Mr. Saut said.

The S&P 500 finished Monday at 1977.65. It is up 7% year-to-date after last year’s 30% surge and has nearly tripled from the March 2009 bottom.

Mr. Saut isn’t the first market watcher to call for a big pullback. And he won’t be the last. The Dow and S&P 500 haven’t suffered 10% drops since the second half of 2011. Over the past three years, countless strategists and investors have argued that the market was due for a breather. Each time, those prognosticators were proven wrong.

Considering 2014 is a midterm election year, a 10% correction wouldn’t be overly surprising. Since 1962, the S&P 500 has suffered a drop of at least 14% in 10 of the prior 13 midterm election years, according to Strategas Research Partners. In the other three years, pullbacks ranged between 8% and 9%.

With the Dow surpassing 17000 and the S&P 500 eyeing 2000, calls for a pullback are expected to increase.

“The bull market is very much intact, but that round number resistance at 2000 in the S&P 500 and 4000 in the Nasdaq Composite may prove to be tough levels to surpass in the immediate future,” said Michael Shaoul, chairman and CEO at Marketfield Asset Management.

Others share similar sentiment.

“We’re clearly overbought,” said Frank Cappelleri, a sales trader at New York brokerage firm Instinet. “But even if the advance continues, the rate of ascent is most likely to slow.”

As we noted yesterday, the market has a history of jostling around milestone markers such as Dow 17000. That’s another reason why it wouldn’t be surprising to see the rally pause at current levels.

As for Mr. Saut of Raymond James, his call will either look pretty good, or go down as another failed market-timing prediction.

“This feels more like a crescendo to me rather than the start of a new leg to the upside,” Mr. Saut said.

STOCKS TO WATCH

Alcoa is slated to release its second-quarter results after the market’s close on Tuesday, with analysts expecting per-share earnings of 12 cents on revenue of $5.61 billion. Alcoa is the company that’s traditionally seen as kicking off earnings season each quarter.

Allergan, the Botox maker, could stay in the spotlight after activist investor William Ackman’s Pershing Square Capital Management proposed a new slate of directors for the company on Monday. Shares lost 1.9% on Monday.

PetSmart may remain in focus Tuesday after jumping 2.5% Monday on news that another large shareholder, Longview Asset Management, wants the company to consider selling itself.

Bob Evans Farms is due to release its quarterly results after the market’s close on Tuesday, with analysts forecasting per-share profit of 40 cents on revenue of $331 million.

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